Risk assessment

Moderate growth in the absence of diversification beyond hydrocarbons

In 2020, Azerbaijan’s growth will continue to be supported by hydrocarbon exports despite the expected decline in oil prices. Gas production, linked to the start of operations at the Shah Deniz II field, has grown exceptionally, partially offsetting the downturn in oil production and prices. The substitution of gas for oil is set to continue with the launch of the Absheron platform around 2021. The completion of the TANAP pipeline has made it possible to start delivering gas to Europe, and the Trans Adriatic Pipeline will extend these deliveries to Italy in 2020. In construction, the outlook is more lacklustre: high real estate borrowing rates, a housing market saturated with abundant supply, and the completion of major projects (particularly the relocation of refugees) point to a slowdown. Despite diversification efforts, the growth of the non-hydrocarbon sector is limited to agriculture and tourism, and is based on various subsidies and incentives.

Private consumption has benefited from measures to resolve non-performing loans and repeated increases in the minimum wage, pensions and public sector wages (+40%). This has allowed a shift towards domestic and non-oil activity, but will have a negative impact on inflation and public finances. The banking sector has been restructured: banks have returned to profit, are better capitalized and the non-performing loan rate continues to decline (around 10.9%), supported by a presidential decree announcing compensation for debtors affected by devaluation. Dollarization of deposits remains high. Inflation was kept under control in 2019 and is expected to remain moderate in 2020 as inflationary pressures are offset by moderate food prices. Accordingly, the central bank is expected to continue its monetary easing, contributing to the credit momentum already seen in 2019.

Current account and public surplus due to hydrocarbons

Azerbaijan’s public finances have become more transparent, thanks to a fiscal rule requiring the primary non-hydrocarbon balance to be improved every year, keeping expenditure growth below 3%. According to the 2020 budget, the State’s non-oil revenues are expected to increase by 11.3%, allowing for an increase in expenditure accompanied by a reduction in the non-hydrocarbon primary deficit (31.1% of GDP in 2019). Expenditure will support growth, while putting downside pressure on inflation, while fiscal efforts will ensure debt reduction in the coming years. State-owned companies are a drag on public finances because of bailouts and state-guaranteed debt. They occupy key sectors and despite the stated intentions, no privatization list has yet emerged.

Azerbaijan has a large current account surplus, thanks to hydrocarbon exports (95% of the total) which, despite declining, are enough to fully finance imports as well as the services and primary income deficits. Non-hydrocarbon exports have improved slightly, but continue to have a narrow base (aluminium, fruit and vegetables). The current account surplus should be maintained despite lower oil prices in 2020. Reserves are slowly being replenished and will make it possible to maintain the fixed exchange rate, which, despite being overvalued, is seen as essential to macroeconomic stability and to anchoring inflation, and is thus expected to remain an obstacle to economic diversification in 2020. The country is struggling to attract FDI, which has been declining steadily since 2014 and is focused on the hydrocarbon sector (86.2% in H1 2019).

Reform efforts hampered by rising oil prices

President Aliyev was re-elected for a fourth term in 2018. Heir to his father, already president of the Azerbaijan SSR, Ilham Aliyev leads a highly repressive political line and has virtually suppressed the opposition. Parliament plays a secondary role in relation to the executive. The business climate is characterized by corruption and discretionary law enforcement. The competitive model chosen by Azerbaijan relies on large multi-sector conglomerates - very closely linked to the State - allows opportunities to be preached by established players, and leaves little room for new entrants. This apparent monolithism hides some evolutions: the oil crisis has given the country a reforming impulse and the government is seeing the arrival of a new generation of decision-makers, the «Pasha boys», more influenced by Western management methods. The recent dissolution of parliament and the reshuffling of the cabinet are symptomatic of this trend. The next parliamentary elections will be held on 9 February and are expected to be more open than usual. Petty corruption has declined thanks to the implementation of digital state services, a policy of support for VSE-SMEs, including tax benefits, is being implemented, and major reforms of banking regulation are under way.

Surrounded by neighbours that are under sanctions (Turkey, Iran, Russia), Azerbaijan is seeking to position itself as a logistics hub on the North-South and Transcaucasian corridors, of which the benefits are taking time to materialize, while trying to build closer ties with the EU. Although the risk of conflict with Armenia is contained by the influence of large neighbours, the rhetoric of both sides remains violent and a peaceful solution is not in sight.